People fantasize about winning the lottery and facing a delightful myriad of saving and spending decisions. While only a select few are lucky enough to meet such good fortune, many others come into large sums of money through more conventional routes.
A large inheritance, divorce settlement, lump-sum retirement distribution, or insurance settlement can bring a windfall. Whatever the source, the challenge is the same: how best to handle this new-found wealth. The California Society of Certified Public Accountants offers the following advice.
Take the Equivalent of a Financial Deep Breath
In other words, don't rush into anything. Don't quit your job, sell your home, or book a round-the-world voyage -- at least not right away. It's important to take some time to put everything in perspective. Since this good fortune can dramatically alter your lifestyle and your financial goals, you need to take some time to get used to your new wealth and to consider your options carefully. In the meantime, it's a good idea to put the proceeds of your windfall in a money market mutual fund, Treasury bills, or some other safe, liquid investment.
Plan for Uncle Sam's Share
Before you start spending or investing your dollars, you need to meet with a CPA to identify your options and to determine the potential tax bite on your money. There's no income tax on gifts or inheritances, but lottery payoffs and other windfalls come with important tax implications.
Should you have the option to take your windfall in a lump sum or in a series of payments, a CPA can help you select the right alternative. For example, by rolling a 401(k) lump-sum distribution into a self-directed IRA at a bank, brokerage firm, or mutual fund company, you can remain in a tax-deferred situation until you start taking distributions. And while you may not be able to shelter lottery winnings, with professional advice, you can lower the tax bite on the money your windfall earns for you. In any case, a large windfall is likely to push you into a higher tax bracket and intensify your need for tax planning.
After you've established short- and long-term financial goals, you can begin to develop strategies for putting your money to work. Your objective should be to devise an investment plan that preserves your capital. If you're not experienced in managing a large sum of money, seek advice from an investment advisor or financial planner who is well qualified and trustworthy, such as a CPA who is accredited as a Personal Financial Specialist (CPA/PFS)by the American Institute of Certified Public Accountants, or who may also hold a Certificate in Educational Achievement (CEA) from the California CPA Education Foundation.
Working with this individual, your first step is to create an asset allocation plan that includes not only your new fortune but also your home, your retirement plans, and other existing investments. Then work with your advisor to build a sound portfolio by diversifying your assets among a variety of appropriate investments. To minimize risk, don't treat your windfall as an excuse to ignore the basics of prudent investing and the need to diversify your investments. Finally, using your financial goals as a basis, your advisor can tell you how much you can prudently take each year from your financial windfall.
Learn How to Say "No"
It's likely that friends, relatives, and charities will make it important for you to learn how to say "no," or at least, "not yet." Don't allow yourself to be pressured by those looking for a handout until after you have identified your goals and have a financial plan in place. If your winning is public knowledge, you also should be prepared to deal with a deluge of "can't lose" scams.
Review Your Estate Plan
Proper estate planning is critical for reducing estate taxes. Work with an attorney who specializes in estate planning to update your will. He or she also can help you create trusts and gift-giving plans for passing your new-found wealth on to your children and/or your favorite charities. Whatever you do, don't underestimate the value of estate planning.
If you thought struggling to pay the bills was tough, you might be surprised to learn of the work involved in managing a large sum of money. If you need help in handling the tax and financial planning aspects of managing a windfall, consult with your CPA.
Have Some Fun
Once you can put a price tag on your tax bill and have some idea of what's left of your after-tax windfall, earmark an appropriate portion to spend on something frivolous that you might not have done otherwise. It's okay to get that shopping spree or travel lust out of your system, as long as you don't foolishly squander all of your funds.